The ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost.

It also provides a mechanism for identifying different categories of stock that will require different management and controls.

The ABC analysis suggests that inventories of an organization are not of equal value. Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance.

'A' items are very important for an organization. Because of the high value of these 'A' items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern to avoid excess capacity.

'B' items are important, but of course less important than 'A' items and more important than 'C' items. Therefore, 'B' items are intergroup items.

'C' items are marginally important.

It is frequently used by inventory managers to put their efforts where greatest benefits, in terms of cost reduction as well as maintaining a smooth availability of stock are attained.

Difference between ABC analysis and XYZ analysis

ABC analysis classifies the raw materials based on their consumption during a particular time period (usually one year).

XYZ analysis is more used in relation of the customer demand for finished goods.

X is high demand, Y medium demand, Z very low demand.

ABC/XYZ Analysis is used to generate the strategy for the supply and inventory control and production strategy.

The ABC analysis is a primary analysis. It can be used as a basis for follow-up or secondary analyses for XYZ analysis.